(Madoff lawsuit story updated for Bank of New York Mellon unit's comments)

NEW YORK ( TheStreet) -- Attorney General Andrew Cuomo of New York is suing a Bank of New York Mellon ( BK) fund of funds unit, Ivy Asset Management, for sitting by idly and doing nothing to warn investors about Bernie Madoff's massive fraud.

Attorney General Cuomo is alleging in the suit that emails and internal documents between former top officials of Ivy Asset Management show that the fund of funds unit of the Bank of New York Mellon allowed its investors to lose $227 million in Madoff funds to protect its own fee generation.

The lawsuit alleges that Ivy Asset Management former officials had discovered that Madoff was not being straight about his investing, yet kept a lid on their concerns as they earned about $40 million between 1998 and 2008 for advising Madoff investors.

Cuomo's suit alleges that Ivy officials figured out that Madoff was clearly cooking the books as early as 1997. Cited in the lawsuit is data on the volume of outstanding options tied to the Standard & Poor's 100 Index supporting only half of the Madoff assets under management.

The lawsuit includes this from an Ivy internal memo: "This is a clear example of our inability to make sense of Madoff's strategy, and one where his trades for our accounts are inconsistent with the independent information that is available to us."

Ivy's former chief executive, Lawrence Simon, and its former chief investment officer, Howard Wohl, are named in the lawsuit brought by the New York attorney general, who is also planning a run for the governorship of New York State.

"Ivy and its former co-principals saw the trouble with Madoff coming around the bend, but instead of guiding their clients through the financial waters, they sold them down the river," Mr. Cuomo said in a statement. "They shamelessly profited off of their own clients' impending misfortune and we are holding them accountable for their actions."

Yet Cuomo says that the former Ivy officials did anything but act on the evidence. In fact, in 1999, a letter from Ivy to clients reported that " We have no reason to believe there is anything improper in the Madoff operation."

Ivy officials went further in defending Madoff in communications with clients between 1998 and 2004, saying their one concern was an "ability to manage what must be an enormous pool of capital with such consistently outstanding results."

Douglas Squasoni, Chief Restructuring Officer of Ivy Asset Management, issued the following response to the lawsuit on Tuesday: "Ivy takes its responsibilities very seriously, and our first priority always is to protect our investors and clients. Unfortunately, a limited number of clients from a legacy non-discretionary advisory business of Ivy were among Bernie Madoff's victims when his plot was exposed in December 2008.

These non-discretionary advisory clients were primarily professional investment advisors who chose to maintain Madoff exposure for their own clients. Ivy informed its clients that it had questions about Madoff that it could not answer and recommended to its clients that they reduce their exposure to Madoff.

The non-discretionary advisory business that is the focus of this complaint was never part of Ivy's core proprietary fund of hedge funds business, and is no longer in operation.

Further, the Ivy executives involved in this matter left the company in 2008.

We have been cooperating with the Attorney General's investigation and intend to defend ourselves against these claims."

-- Reported by Eric Rosenbaum in New York.

Follow TheStreet.com on Twitter and become a fan on Facebook.
Copyright 2009 TheStreet.com Inc. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed.

If you liked this article you might like

JPMorgan CEO Jamie Dimon's 'Embarrassment' Could Grow as Debt Debate Looms

Wells Fargo Board Took 'Strong Actions' to Improve Itself, Ex-SEC Chief Says

The Exact Level to Buy JPMorgan, Citigroup and Other Big Bank Stocks

14 Bank Stocks That Will Either Surge or Do Nothing